Even as oil prices surge to nine-year highs, many oil stocks remain surprisingly cheap. That's particularly true of the smaller major domestic oil players, analysts and investors in the energy sector say.
Making this story especially compelling is that even as $26-a-barrel oil fills their coffers with cash, these companies are restructuring and slashing costs. That improved efficiency means they'll be more attractive to potential buyers when the next wave of consolidation sweeps the industry.
The "bigger is better" philosophy, as well as the market's voracious appetite for anything tech-related, has fed a yawning valuation gap between non-oil and oil stocks, as well as between the first- and second-tier oil majors. For instance,
, at Tuesday's close of 48 1/32, trades at just under seven times next year's estimated cash flow. By comparison,
trades at 13 times next year's cash flow estimates.
So aside from oil's movement or progress in cost-cutting, some of these stocks are just plain cheap. "I'm bullish on Phillips," says Fadel Gheit, an analyst at
in New York who rates it a buy. "It's undervalued on a pure asset play, and it really is selling at a tremendous discount on price-to-earnings and on price-to-cash flow," he says. Fahnestock hasn't done any underwriting for Phillips.
Other companies that are cheap by these measures and stand to gain from industry trends include
, observers say.
While the year-to-date gains for most major oil companies haven't kept pace with oil's gains, the second-tier companies are mostly selling at lower price-to-earnings ratios than the supermajors, based on this year's estimates. Overall, their estimated 2000 price-to-cash-flow ratios are much lower as well.
Of course, some of these stocks are cheap for a reason. Phillips, for instance, is trying to regain investor confidence following a lack of exploration success and a failed joint venture with
Ultramar Diamond Shamrock
. It now plans a major acquisition program and is concentrating on lowering its refining and marketing costs. Occidental has dealt with shareholder unhappiness stateside and a continual barrage of guerrilla activity related to its interests in Colombia. And the oil-price trough of 1998 hurt earnings. Only this year were losses reversed.
Historically, oil companies have sold at about a 15% discount to the
Standard & Poor's 500
on a price-to-earnings basis. That gap has widened to 25% lately, says Gene Gillespie, who follows the oil majors at
Howard Weil Labouisse & Freidrichs
in New Orleans. That discount reflects investor sentiment that oil is too high and will eventually trend down to $18-to-$19 per barrel range, closer to historical norms, he says.
The oil price futures strip on the
New York Mercantile Exchange
backs that sentiment: Oil for delivery in December 2000 settled Monday at $20.24 per barrel, well off recent highs. Prices climbed steadily from the $13 first-quarter average, but by October, skittishness hit the market on fears over
compliance with its production-reduction pact. After dropping near $20 per barrel, the climb resumed.
*Q4 is estimated. Source: Arthur Andersen, Merrill Lynch.
Higher prices will fuel earnings growth, and shares. "Ultimately, the valuation gap will close in favor of the domestic integrateds," this so-called second tier, says Adam Sieminski, energy strategist at
Deutsche Banc Alex. Brown
in Baltimore. Earnings momentum will increase heading into the first quarter, he says.
Fit and Trim
Earnings should grow even if oil prices fall back to the $20 level, as cost-cutting kicks in.
Already companies have targeted nearly $14 billion in savings, estimates
. Stronger earnings were reported in 1995 after a bout of low oil prices in 1993-1994 that sparked a wave of cost cutting.
Last year's low prices sparked an even stronger wave of cost-cutting: Occidental, for example, is targeting $350 million in cuts. Those cuts, and the $775 million
owes it after settling a long-running legal battle, will benefit its bottom line. Los Angeles-based Occidental is expected to earn 51 cents this year, rising to $1.11 next year, according to
First Call/Thomson Financial
Most of the second-tier majors are cutting as well: Phillips is shooting to save $230 million, USX-Marathon $125 million and Conoco $60 million.
But perhaps the strongest argument for looking at these companies is continued consolidation.
After Exxon has merged with Mobil,
, the industry will look first to Chevron and
to see whether they will be buyers or sellers, analysts say.
Chevron, citing company policy, declined to comment.
Texaco hedged: "We are always looking for opportunities to improve shareholder value," says Texaco spokeswoman Faye Cox. "We would never speculate on any particular opportunity, but we are always looking at opportunities."